Model DROs Input

[Guest Kevin Wiggins]

I am preparing forms of model DROs to give to my state bar to use as a form for family law attorneys. Since you all are the experts and since you may have to deal with these, I was wondering if anyone would like to provide any input.

[Harwood]

Deal with the issue of the plan loan "asset" in many Defined Contribution plans.

[QDROphile]

Make it very clear that they can't use the form except as a very rough guide, almost like an issues checklist. They commit malpractice if they don't understand the law and the plan. Most will not understand the law. Most will not take the time to understand the plan, because it is not ecomomic. The model, no matter how good it is, will not make up those gaps. The model cannot anticipate all plan designs. For example, some DC plans don't allow immediate distribution to APs even though everyone thinks that is a God-given right.

The Texas bar published an abominable form with a provision that is almost incomprehensible and the "drafters" have no clue what it means. But, everything is different in Texas, isn't it?

You might warn that the model has to be modified to take into account any local court rules.

The DC model should deal with vesting, allocation of earnings, plan loans (included in the calculation of the amount to be divided or not). Can plan loans be divided or assigned to the AP? Legally, they can but it is tougher than sounds and many systems, such as Fidelity's, can't accommodate. How are investments allocated -- usually prorata. Don't allow the order to give the AP an amount and not earnings from some point of creation of the AP's interest. Many systems, including Fidelity, can't do that correctly. The model needs to take into account that not all plans are daily valued -- the division of benefits has to take into account valuation dates.

I don't think you can produce a decent model for a DB plan unless it is for a specific DB plan. The best that can be done is guidelines and a description of issues that must be addressed, with some suggested approaches.

[Kirk Maldonado]

Expanding upon Harwood's comment, clarify that the participant is responsible for repaying any outstanding loans.

Clarify that the QDRO can't provide that a portion of the proceeds are to be used to pay the alternate payee's attorney's fees.

[david rigby]

In the DB-related DRO's that I see, I continue to hope the order will address the question of death; 4 cases.

- if the participant dies first and before any benefit commencement,

- if the AP dies first and before any benefit commencement,

- if the participant dies first after benefit commencement,

- if the AP dies first after benefit commencement.

[mbozek]

Tell them to check with the plan admin. to see if there is a model QDRO which can be used. Also many M/P and 403(b) vendors have model documents. They should be aware that the custodian /trustee for a M/P or volume submitter plan cannot approve a QDRO because it is not the plan admin. They should be aware that a QDRO cannot be used to divide IRAs because the custodian is not a fiduciary. There needs to be a separate provision dividing the IRA under IRC 408(d)(6).

[Guest Kevin Wiggins]

Thank you all for your input. You've all addressed issues I've considered, but many raise other issues that I think must eventually be addressed by the plans once the family law attorneys start to understand these issues.

For example, QDROphile, you said to deal with vesting. If the P is not vested, the AP receives a cash out (and forfeits), then the P receives a cash out (and forfeits), then P is later re-hired and buys back his vesting, can the AP buy back her vesting as well? (I'm assuming the AP here is a "she").

I don't know of any plan that has dealt with this, and fortunately I have not yet done a QDRO for a less than 100% vested participant. But I can see the issue coming. One answer is just assign a larger portion of the currently vested benefits to the AP, but what if the other side or court won't agree to that? Most courts like to take the "wait and see" approach.

Another issue is why won't DC plans let the AP be named as the surviving spouse? This can be a critical estate planning/community property issue.

Of course, none of this will go in the model QDRO.

[Mike Preston]

AP's cannot cause a forfeiture by taking a portion of the participant's benefit. AP's can only be paid a portion of the participant's vested benefit. What is left behind is the participant's benefit.

[QDROphile]

A QDRO should be able to name an alternate payee as a surviving spouse under a DC, but usually it is not necessary to get death protection as it is in defined benefit plans. As you have observed, there are other legitimate reasons to do it.

I am sorry I don't have time now to pontificate about vesting. I sort of agree with Mike Preston, but I think his statement leaves a lot more to be said. I have had to work through some of the issues, which are more interesting from the plan's perspective than what one writes in the order. The QDRO procedures should speak to vesting and the order should try to comply.

[Appleby]

Tell them to check with the plan admin. to see if there is a model QDRO which can be used. Also many M/P and 403(b) vendors have model documents. They should be aware that the custodian /trustee for a M/P or volume submitter plan cannot approve a QDRO because it is not the plan admin. They should be aware that a QDRO cannot be used to divide IRAs because the custodian is not a fiduciary. There needs to be a separate provision dividing the IRA under IRC 408(d)(6).

mbozek, you raise an important issue. We constantly receive numerous QDROs for IRAs. As recent as today, we receive a very threatening letter from a lawyer, demanding that we (the IRA custodian) provide a sample QDRO to his client or indicate whether the sample the lawyer provided meet our requirements. The letter and the sample QDRO made several references to IRC Sec. 414(p), the plan under IRC 401(a), the IRA custodian and yet referred to the account in question as the “IRA”.

[Guest Kevin Wiggins]

Mr. Preston:

I'm not talking about a forfeiture made by the AP's distribution. I'm talking about a forfeiture made by the Participant's cash-out. Here is an example.

The QDRO valuation date is Date x.

P has $100,000 on Date X - $50,000 in 401(k) and $50,000 in match.

On Date X, P is vested 20% in the match (I know - just pretend he had some excellent investments in his first year of participation or take off a couple of 0s if you like).

The QDRO awards AP 50% of P's benefits, pro rata from each account, pro rata from each investment, and pro rata from vested and unvested benefits. AP is vested to same extent as P and forfeits in same proportion as P's unvested percentage at time of distribution to AP.

Based on the QDRO, AP gets $25,000 from 401(k) and $25,000 from match. However, AP is only 20% vested in the $25K match.

One year later P is 40% vested. Accordingly, AP is also 40% vested.

That year AP takes a distribution and forfeits 60%.

A year later P is 60% vested, terminates, takes a distribution, and forfeits 40%.

Two years later P is rehired. P repays the distribution and continues vesting, per 411 and the regs.

Query: Can AP repay and continue vesting upon P's rehire? Does it matter whether P repays?

It seems to me the answers should be "yes" and "no" assuming a properly drafted QDRO and assume you read the DOL's advisory opinions to say that any right P has under the plan can be assigned to AP (other than a JSA to AP and successor spouse) in a QDRO. It also seems to me there is no way that certain, to remain unamed TPAs would ever accept this, much less understand it. Also, like most QDROs, this does not become an issue because there is not enough money involved (and is not a issue now except for drafting the model QDRO provisions). I can, however, see this possibly coming up someday.

[mbozek]

A: I have had similar run ins while reprepresenting IRA custodians with divorce lawyers who refuse to admit their ignorance regading the division of IRAs. One lawyer who represented his father in a divorce (?) told me he would have me held in contempt because I refused to accept a QDRO he had a ct approve for an IRA. He refused my offer to revise the order to divide the IRA. I dont know if the IRA was ever divided but I never heard from him or the court. There seems to be a misconception among the divorce bar that custodians must accept QDROs once they are approved by a court. They never read the custodial agreement to see how the IRA is divided in divorce and think that custodians will cave in to intimidation. If you need help blowing them off let me know.

[Mike Preston]

Mr. Preston:

...

The QDRO awards AP 50% of P's benefits, pro rata from each account, pro rata from each investment, and pro rata from vested and unvested benefits. AP is vested to same extent as P and forfeits in same proportion as P's unvested percentage at time of distribution to AP.

I don't know who this Mr. Preston guy is. This is a Message Board, not a formal client meeting. You keep that up and I'll start bugging you about going back to that unfinished thread where I needed you to comment so as to bring the discussion back to earth! ::smile::

Anyway, I would advise that a client reject the QDRO as you have described. There is no way that a distribution at the time to AP can cause P to forfeit a portion of P's account. At least I hope that isn't the way a court would try to force a plan to operate.

The DRO can certainly allow that the AP become entitled to additional funds, even after a partial distribution to AP, as the participant vests. Good luck writing the formulas out, either in English or in equation format, though. My head hurts just thinking about it. And if you can't write it out such that a Plan Administrator merely needs to read it, understand it and implement it, I don't think it flies.

However, getting to the meat of your questions. I agree with you, after a bit of reflection, that the answers are "Yes" and "I don't have a clue". I can't imagine a plan willingly allowing an AP to be the only one to repay monies to the plan. I don't see the DOL position as providing rights to the AP that are not administratively implemented in the body of the plan. If a plan calls for repayment, then repayment must be complete. Maybe the DRO can give the Ap the right to repay if the P wants to do so. But, boy, would that be complicated.

Let me change the subject a bit. If the AP and P don't take a full distribution, then the repayment issue never comes into focus. Instead, the partially vested and partial distribution rules come into play. Plans have formulas for determining vested interest in accounts where partial distributions have taken place. Either V%* (AB + D) – D; or V% * (AB+(RxD))-(RxD), where R = the ratio of the AB at time of distribution to the AB at the original distribution. Whichever the plan uses defines the benefit that is vested for the participant.

Your point related to how the plan handles further vesting and benefits that might be owing the AP once the AP alone takes a distribution is a good one, and one I haven't spent a lot of time with, because usually a participant is 100% vested long before the assets are sufficient to fight over with a DRO. A point you made as well.

I would encourage anybody writing a model DRO to either ignore the AP's independent repayment rights (since they don't exist at the moment - or at least I haven't seen any court cases that talk about them) or to specifically acknowledge that a distribution, once taken by the AP, is not eligible for repayment, even if the P is eligible upon a subsequent rehire to repay the previously distributed funds unless, at that time, the P and the AP agree to repay the plan together.

[Guest Kevin Wiggins]

For the model DRO I think I'll just leave it out. That is good advice on writing the QDRO to say either AP can't repay or both repay if both agree. The other thing to do is to order that both will repay.

Another question is whether, when the AP forfeits, the unforfeited portion reverts to P? Or is it a forfeiture and used just like any other forfeitures?

These questions are more academic than real. I'll save the rest for when they really come up.

[Mike Preston]

I don't think the AP ever "forfeits". Only the P can forfeit. Unless a plan is written such that a separate account established for an AP can be seeded with not yet vested, as well as vested, monies, I just can't see a forfeiture. And I have yet to see a plan that is worded that way.

General rule: pay AP what QDRO says, P gets what is left.